Should You Invest In Gold In 2024?

Bankers are a rational bunch unless you talk to them about Football or Gold.

Gold is a controversial topic, and there are a lot of misconceptions about it and facts that may surprise you. Some investors avoid it, since it does not generate any yield. But, portfolio managers and traders, including prominent ones, allocate personal savings to Gold.

If we don’t subscribe to the doom predictions of gold bugs and take emotions out of the equation, is buying Gold a wise choice?

Let’s look at the good, the bad, and the ugly behind Gold.

KEY TAKEAWAYS

  • Gold is riskier than you think. Its volatility over the past 17 years was 17.2%, higher than the S&P 500, at 15.6%.¬†
  • Gold may disappoint when you need it the most. Due to market-wide liquidations, Gold is prone to short-term sell-offs during a crisis – at exactly the same time as stocks.¬†
  • Yet, a reasonable but modest allocation in a portfolio works well. It offers¬†diversification, and¬†reacts during longer stress periods, like in the 1970s. A recent study from Robeco suggests a 5-15% portfolio allocation to minimise risks.
  • An insurance has an opportunity cost.¬†Gold may hedge periods of hyperinflation and/or wars. In between, Gold can underperform for decades, since it doesn’t generate any yield.¬†
  • By some metrics, Gold looks vulnerable. That’s because Gold often tracks the opportunity cost of holding a much better diversifier – Bonds. If Gold was only correlated to real yields, its price today would be below $1,300 or even lower, depending on the model.¬†
  • Today, a 1980s-style Gold crash is held up by inflation and geopolitical uncertainty –¬†in Europe, the Middle East and potentially around Taiwan.¬†
Here is the full analysis

I hate gold and I have always hated gold. Unfortunately, I own gold. I think I have two fears. One fear is deflation and one fear is inflation and I have learned through history that there is no such thing as inflation anymore.There is hyperinflation or nothing. Now we are in a deflationary environment. It can switch very easily from there because there is so much money out there. So I want to hedge and make sure my funds and my savings are unaffected by both deflation or hyperinflation.

Why Would you care about gold?

Bankers' Ultimate Currency

Forget About Jewellery, Gold Is A Financial Asset.‚Äč

A Bloomberg Terminal keyboard WIth its asset classes

bloomberg terminal - gold price
bloomberg terminal keyboard gold as currrency

For the finance community, Gold is the ultimate currency. In fact, on Wall Street, when you use a Bloomberg terminal, we press ‘Currency’ to get information about Gold. 

Gold’s value as a commodity in industrial processes is marginal. According to the World Gold Council‚Äôs data, it accounts only for about 17.5 per cent of the total demand for gold.

Holding Gold shows your capabilities

Joe Weisenthal, from Bloomberg has in my opinion summarised the historical importance of  Gold in the best way. Here is his take. One of the striking things about gold is just how incredibly hard it is to attain. And hold onto it once you have it.

To get Gold, you have to:

  • Be good at warfare
  • Be able to marshall an extensive human workforce to mine it
  • Achieve mastery of global supply and logistics routes
  • Be able to command guards who will watch your gold, and not steal it
  • Have the technical know-how to get gold out of the ground, which is expensive and
    cumbersome

When you have gold you’re communicating all the different things you’re capable of. Mastering supply routes, commanding an army, scientific endeavour, marshalling labour, etc. Gold, then, is a very specific proof of work. If you can get gold, you’ve proven that you have the ability to run a state or some state-like entity.

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The Bad - Gold is Risky

Is there a downside to buying gold?

As with all currencies, Gold has no yield

Unlike bonds, gold does not pay interest. On top of that, you also need to account for storage costs.

Gold is very volatile

On its own, Gold is a volatile asset. Assuming a 5-year holding period, you may have faced up to a 40% loss on several occasions over the past 3 decades. Look at the below graph of Profit and Loss on $1,000 invested in Gold and held for 5 years.

During stock market crashes Gold may plunge

But, it gets worse. It crashes with Stocks. That sounds counterintuitive, doesn’t it? Isn’t Gold supposed to work as a hedge? Not¬†in the short term.¬†You can see that there is a short term sell-off period for Gold, in the middle of the GFC. The same happened in March 2020. Liquidations of other assets have a short term impact on Gold price.

However, Gold acted as a great long term Equity hedge. It has returned up to 280% in 2010/11 if held for a 5-year period.¬†So the good news is that, in the medium-term, more often than not, a crisis comes with at least one of risk factors –¬†geopolitical tensions, deflation, or expectations of very high inflation, ultimately¬†acting as a positive catalyst.¬†

Net Profit on $1,000 invested in Gold 5 Years earlier

gold volatility for 5 year holding period XAU USD GLD
Data: 1985-2020. Source: Bloomberg, Bankeronwheels.com.
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From Bankeronwheels.com
Today's prices are not coming back!

In 2024, we Will be increasing coaching service prices.

Sometimes individual sessions are very helpful to get past your investing concerns. Our readers asked us to create a coaching service. And we’re proud to say, that some of them even ditched their Financial Advisors, after experiencing the value we provide.¬†Some of the topics we recently discussed include:

  • How much money do I need to retire with higher inflation?¬†
  • Medium Term or Long Term Bonds with today’s yields?
  • Risks and Returns of Money Market Funds¬†¬†
  • Asset Allocation for 10-15 year goals with narrowing returns between Equities & Bonds
  • Merits of UK Trusts that invest in unlisted companies
  • Traps with choosing brokers – PFOF & Risks of moving to another country
  • International Situations – Choosing ETFs when leaving Europe¬†

The Ugly - Gold can underperform for decades

Is Gold a good investment for the Long Term?

No. In fact, I think it's a stretch to call it an investment.

I think it’s a stretch to call it an investment, similar to other currencies. I would rather call it a diversifier.¬†So, what if you invested at the top of the market? It’s a great way of looking at what losses you can sustain if looking at Gold in isolation. Below is the graph representing scenarios where you would have invested at market peaks.

It took Gold three decades to bounce back – Gold peaked in the early 1980s and only recovered in 2007.

Loss on $1,000 invested In gold At market peaks

gold drawdowns since end of gold standard 1973 2020 in USD
Source: Bloomberg, Bankeronwheels.com.

If you don't own gold...there is no sensible reason other than you don't know the history or you don't know the economics of it.

The Good - Gold in a Portfolio works well

Does It Still Pay to Invest in Gold?

It does, even though it doesn't generate income.

Now, here is the paradox. To put it mildly, it’s not an attractive asset. But it still¬†makes sense to own it.¬†

Gold provides very good diversification benefits. It is inferior to U.S. Treasuries, but if yields are low, holding Gold (and other diversifiers like Bitcoin) has very low opportunity costs. While Gold is volatile on its own, within a portfolio with Equities and Bonds, a small allocation may improve the risk/return profile of your portfolio.

Gold Diversification vs Stocks and Bonds

Source: Bloomberg, Bankeronwheels.com. Data set: 1999-2019.

Gold has a place in a Long Term Portfolio

In a world where wars are likely, in a high inflation environment Рeven with high rates Рthere are scenarios when other asset classes will underperform. During those times, rebalancing from performing Gold to poorly-performing assets that in the long run do generate income Рand are on sale Рcan yield dividends. But, it may require patience and rigour, due to immediate market-wide asset liquidations that may initially affect Gold.

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Gold allocation

How much gold should you have in your portfolio?

A modest allocation between 5-15% is the sweet spot

According to a June 2023 study from Robeco, that analysed 1975-2022 one-year returns, by adding Gold to a 50%/50% Equity/Bond portfolio, the additional Gold allocation should be modest:

  • Allocating more than 20% to gold leads to higher risk and lower return –¬† these portfolios are clearly inefficient.
  • Under-allocating (<5%) – won’t probably have enough effect on risk reduction metrics.

Depending on the choice of risk measure, the optimal gold allocation varies between 5% and 15%:

  • 5-10% if based on the Sortino ratio – which is a performance metric that measures the risk-adjusted return, focusing specifically on downside risk, and helping investors assess how well the portfolio performs relative to the risk of negative returns. The highest ratios are around 5-10% allocation.
  • 10% if based on Loss Probability – With a 10% allocation, loss probability drops from 26.6% to 22.4%. Above 10% the loss probability remains similar.
A 15% allocation may have some merits based on expected loss, but at 20% the negative effect on returns becomes more significant. 

Adding gold to a 50/50 equity/bond portfolio (1975-2022)

Gold AllocationReal Return (%)Loss Probability (%)Downside Volatility (%)Sortino Ratio
0%6.126.63.91.56
5%624.33.71.61
10%5.922.43.71.61
15%5.822.63.71.57
20%5.622.63.71.5
25%5.522.03.81.42
30%5.323.841.32
35%5.126.84.21.21
40%4.927.54.51.09
45%4.729.74.90.97
50%4.532.15.20.85
Source: The Golden Rule of Investing, 24 Jun 2023, Pim van Vliet, Harald Lohre, Robeco Quantitative Investments, Lancaster University Management School.

In summary, that’s all you need to know about Gold. You don’t have to understand the technical details to be able to benefit from diversification.¬† However, it can be interesting to have an intuition of what really makes it a different asset and when you may need it. Let’s have a look at some price drivers.

What drOvE gold prices in 2023?

Gold Is driven by 5 factors

But only some of them matter today

$100 bn of Gold trades daily, mainly in London. As you would have guessed by now, it is mainly a financial product. Almost all factors below affecting its price are financial in nature:

#1 Opportunity Cost

How much does it cost to hold Gold?

Not getting inflation-adjusted Bond returns

Gold tracked real Yields closely. Until 2022.

Low real yields are the elephant in the room when it comes to explaining Gold price, in the very long run.¬†Investors are turning to gold when inflation-adjusted Bond Returns are unattractive.¬†¬†The lower the¬†Treasury Bonds’ real returns,¬†the more attractive Gold becomes.¬†Up until 2021,¬†in a low yield environment, the correlation between real yields and Gold was very strong.¬†

In the long run, real yields explain 30% of changes in Gold price

According to a BlackRock, real yields explain around 30% of the price of Gold, in the long run.

The past four decades could be broken down into three periods: 

  • 1982-1999 (High Real Yields)
  • 2000-2008 (Decreasing Real Yields)
  • 2009-2019 (Low Real Yields)

When bonds offered positive real returns, Gold returns were lacklustre.

But, the correlation between real yields and Gold prices is not strong in all environments when other price drivers, that we will discuss below, take over.

So, Why didn't Gold crash below $1,300 in 2023?

In the past, a 0.10% drop in yields coincided with a 1.25% increase in Gold.

In 2019, BlackRock estimated that a rule of thumb is that every 0.10% drop in Real Yields coincides with about a 1.25% increase in Gold Prices. If the relationship was maintained, Gold would have crashed in 2023. 10 year Real Yields moved from -0.4% in August 2020 to 2.1% in October 2023. The opportunity cost of not holding Treasuries, in an inflationary environment, is high. 

So, why is Gold not below $1300, or even much lower by other metrics (look at the above graph) today? Read on to understand what offset this trend.

1.25 %
Is the increase in Gold price for every 0.10% drop in Real Yields

#2 HIgh Inflation

Is Gold a good inflation hedge?

Contrary to popular belief, Gold is not a good inflation hedge.

You heard a lot of misconceptions about Gold from me today. That’s before you learn the biggest one.¬†Contrary to popular belief, Gold is not a good inflation hedge.

In fact, if inflation is below 4%, Gold won’t protect you much. In the 1980s and 1990s annual inflation was mostly between 2-4%. On a cumulative 20-year basis, prices increased by 115%, yet Gold lost 54% of its value.

Over 20-years, Prices increased by 115%, yet Gold lost 54%.

YearUS CPIGold ReturnS&P 500 Return
198110.3-32.8-9.7
19826.211.814.8
19833.2-15.017.3
19844.3-19.01.4
19853.66.226.3
19861.919.514.6
19873.624.52.0
19884.1-15.712.4
19894.8-2.227.3
19905.4-3.7-6.6
19914.2-8.626.3
19923-5.74.5
1993317.67.1
19942.6-2.2-1.5
19952.81.034.1
19963-4.720.3
19972.3-22.231.0
19981.60.626.7
19992.20.519.5
20003.4-6.1-10.1
20012.81.4-13.0
Source: Bloomberg, Bureau of Labor Statistics, Bankeronwheels.com.

So, How high will inflation need to be?

Above 4%, and it better be sticky for this hedge to work.

In terms of inflation regimes, Gold returns have generally been most significant during extremely low, less than 1%, or high, greater than 4%, inflation, and this for a long time period.

The 1970s illustrate that relationship. Back then, the real price of imported oil in the U.S. increased sixfold, leading to runaway inflation and stagnant economic growth.  Initially, stock-heavy portfolios were hit the hardest, declining up to 50% within 18 months. Later, as inflation accelerated, bond-heavy portfolios suffered as well, declining up to 40% by 1981. 

Gold provided a great hedge, increasing sixfold.

First reason why Gold didn't crash in 2023

That’s the main reason why you didn’t witness a 2023 Gold crash linked to higher real yields. Gold prices stabilised, but that’s because the real yield effect is offset by high inflation.

Gold exceptional rally in the 1970s

Gold 'invisible' Rally in 2023

But in 2023, sticky inflation is stabilising, isn't gold risky?

Can we have a repeat of the 1980s?

Now, Gold bears may point to the multi-decade slump that started in the 1980s. Since, by some measures, inflation is stabilising, why is Gold not getting weaker today? 

#3 GEOPOLITICAL Shocks

Is gold a hedge against wars?

Second reason why Gold didn't crash in 2023: Ukraine & The Middle East. What If Taiwan Is Next?

Any potential Geopolitical Conflict, including Ukraine, the Middle East, trade wars or potential escalation around Taiwan may also impact Gold and provide a hedge to your Equity portfolio. 

We can’t predict the exact nature of this event, but Gold is an insurance policy in these instances. This is playing out today.

#4 Dollar strenGTH

How do you trade gold?

Gold is quoted in U.S. Dollars

Gold is generally quoted in US dollars per ounce of gold; so any fluctuations in the strength of the dollar are likely to be reflected in the dollar price of gold: when the dollar falls the gold price rises.

Historically, Gold outperformance is strongest when the Dollar is weak. It’s valid over long periods. But, during times of crisis this is a secondary factor. Why? Both the US Dollar and Gold are perceived as Safe Havens, and a stronger dollar doesn’t have a major impact on Gold. In 2023, both the DXY Index and Gold are up.¬†

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#5 Commodity, Retail and Central Bank Demand

Why central banks are stockpiling gold?

Emerging Countries are diversifying away from the U.S. Dollar

Central Bank Gold Reserves In Tonnes (2000-2021)

#Country% Change20002021
1USA-0.1%81398134
2Germany-3.1%34693362
3Italy0.0%24522452
4France-19.5%30252436
5Russia442.6%4232295
6China393.2%3951948
7Switzerland-59.8%25901040
8Japan1.5%754765
9India89.1%358677
10Netherlands-32.8%912613
11Turkey354.3%116527
12Taiwan0.5%422424
13Kazakhstan596.4%56390
14Portugal-36.9%607383
15Uzbekistan88.4%181341
16S. Arabia125.9%143323
Source: IMF, Bankeronwheels.com.

Gold has a traditional demand market as a commodity, in technology, jewellery or protective asset demand from Retail and Central Banks. Retail is largely driven by Emerging Countries and more specifically Asia. 50% of overall Gold demand comes from China and India.

Post GFC Central Banks became net buyers of Gold:

  • Diversification away from the US Dollar: Central banks are also buying gold as a way to diversify away from the US dollar. The Federal Reserve‚Äôs interest rate hikes have caused the value of government bonds to drop. Emerging markets find it beneficial to hold gold as part of their reserves.
  • Political uncertainty: Gold is seen as a store of value that is immune to local political and financial turmoil, making it attractive during volatile times. China, Turkey or India have been particularly aggressive in their gold acquisitions.
  • Circumventing Sanctions: Gold also offers a way to circumvent Western sanctions, particularly those imposed on Russia. Gold transactions allow countries to engage in exchanges that bypass the usual dollar-based international payments system, enabling them to avoid certain geopolitical restrictions. Certain transactions involving gold remain opaque, making it challenging to track all the movements and holdings of gold reserves, especially involving countries like Russia.

Research the appropriate ETFs based on your needs

  • If you decide to invest in Gold you may consider physical gold or a gold ETF.
  • Only consider Gold in a diversified Portfolio (Read how can Gold fit in a Long Term Portfolio).
  • An investment in gold is easily done with listed products, like ETFs or ETCs (How are they different?). These investment products track the spot gold price closely, after taking management and storage fees into account.
  • Performance vary by currency. Gold is quoted in USD and then converged into Fund’s Reporting Currency.
  • I have not included leveraged Funds (understand their risks).
  • Check the size of the fund and liquidity. It is usually preferable to stick to the larger vehicles that are more liquid¬†(why liquidity matters).
  • Low fees are the most cost-effective feature of an ETF ‚Äď make sure you select a low fee vehicle.

Gold ETFs by Exchange

Thank you for reading.
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